After IMF, ADB warns against regressive reforms

ISLAMABAD: In a stark warning, the Asian Development Bank (ADB) has said that Pakistan cannot avail full benefits of the China-Pakistan Economic Corridor (CPEC) without introducing drastic reforms in areas of energy, regulations and foreign currency regime.

In its annual flagship Asian Development Outlook report the Manila-based lending agency released on Thursday, the ADB highlighted the potential benefits of the $55-billion CPEC investment. However, the ADB spoke plainly in conveying a message that the benefits can only be reaped, if Pakistan continued on the path of economic reforms initiated three years ago.

It also said that Pakistan cannot repay its debt arising out of CPEC obligations without attracting non-debt creating inflows and enhancing exports. However, Pakistan is currently implementing a contrasting policy. The government has been building foreign currency reserves by obtaining expensive foreign loans.

The ADB’s advice on reforms come a day after the International Monetary Fund (IMF) also said that Pakistan’s hard-won economic stabilisation was at stake due to challenges in areas of energy, fiscal and external sector. “To reap the potential benefits of CPEC and shift the economy of Pakistan to a higher growth trajectory, the government must continue to address key constraints on growth,” advised the ADB in its chapter on Pakistan.

ADB’s analysis

The ADB said that the government might lend policy support to CPEC implementation by maintaining macroeconomic stability and addressing structural issues that continue to inhibit exports.

It said that domestic security has improved significantly in recent years, but consolidating these gains will take continued efforts.

Regulation remains burdensome, requiring more reform to provide an enabling environment that facilitates businesses and fosters investment, according to the ADB. Reforms to boost exports by diversifying products and markets and by adopting more flexible exchange rate policies are needed to maintain external stability, it added.

A third consecutive year of falling exports reflects weak global demand and low international commodity prices but also domestic structural issues such as power outages, scant investment in modernisation, and currency appreciation in real effective terms, all of which hamper competitiveness, according to the ADB.

Similarly, structural reform to the energy sector and state-owned enterprises are required to fully realise CPEC investments’ productive potential, said the ADB.

A significant increase in the current account deficit could pose a risk to official exchange reserves, which peaked at $18.9 billion in October 2016 and then slid by $1.3 billion by February 2017. The ADB said that expected disbursements from multilateral development partners in the remaining months of the fiscal year will be needed to reverse contraction in the official reserves as of February 2017.

The ADB said that CPEC investments are likely to require significant increases in imports of equipment and services to implement the projects. In the medium-to-long term, these inflows will likely be followed by financial outflows as loans are repaid and profits repatriated to foreign investors, said the lending agency.

“Higher foreign exchange earnings and exports will be needed to avoid pressure on the external account.”

CPEC’s energy projects

According to the ADB’s assessment, the CPEC will significantly address Pakistan’s infrastructure deficit caused by annual spending on infrastructure at only 2% to 3% of GDP in the past four decades. The government has identified ‘early harvest’ infrastructure projects that will be completed in the next few years.

Of these, $21 billion will be spent on energy projects. These will be financed by foreign direct investment from China supported by borrowing from banks there. Independent electricity-generating firms will be offered guaranteed tariffs for their sales to distribution companies that will ensure at least 17% return on equity. About $10 billion in investments in transport infrastructure will be financed by a combination of concessional and commercial loans from China, according to the ADB.

After the IMF, the ADB also noted that Pakistan would miss its current fiscal year’s economic growth target. The GDP growth is expected to remain at 5.2%.

“Continued economic reform is essential to reach a high growth trajectory,” said the ADB. However, it said that investment continued to be at 15.1% of GDP, very low when compared with similar countries in the region, constraining growth.

With national elections scheduled for 2018, the budget to be announced in June 2017 will likely prioritise measures to foster economic expansion, according to the lending agency. It said that average consumer inflation is expected to accelerate to 4% this year due to rebound in oil prices, higher domestic demand, and expanded government borrowing from the central bank. The ADB also expressed its doubts about the government’s ability to achieve this fiscal year’s 3.8% budget deficit target.